Writing ‘Paid in Full’ on Check Doesn’t Erase Debt
Question: I read your comments regarding the effects of filing bankruptcy, and it inspired me to write you regarding a situation I find troubling. A friend of a friend has racked up credit card debt and student loans totaling $100,000. Not securely employed, she has been planning on declaring bankruptcy while continuing her dinners out, lavish shopping trips, a car purchase and vacations, figuring it all will get wiped out soon enough.
She says she is working with a lawyer who advised her to write $10 checks to all her creditors, with a note saying “paid in full” on the check. She was told that by the time they realize it is not payment in full, this lawyer--who is charging $7,000--will step in and dispute the charges.
He says the credit card companies won’t have enough time to research the charges and probably will just drop them. I think she is being scammed herself while she is trying to scam the creditors. She is desperate and doesn’t care, but it makes me angry that people are doing this. Have you heard of this scam?
Answer: This “paid-in-full” nonsense has achieved the status of urban legend, says J. Scott Bovitz, a Los Angeles bankruptcy lawyer. A creditor sometimes will reduce a claim for a disputed payment, but this kind of settlement usually won’t happen if the debtor acts in bad faith, Bovitz says. The act of writing “paid in full” on a $10 check pretty much defines the term “bad faith.”
Your friend also is deluded if she thinks her education debt somehow will get erased. Student loans are among the debts that usually can’t be wiped out in Bankruptcy Court.
She may get stuck with the bills for her spending spree, as well. Bankruptcy judges tend to frown on folks who rack up big bills on luxuries and other nonessential purchases right before they file. In fact, judges think so little of this practice that she might be prevented from going through with the bankruptcy.
Your friend isn’t really desperate. She’s unethical. She understands that she’s involved in something shady and yet she’s participating anyway. She’ll probably get her comeuppance when she’s saddled with all the debts she thought she could avoid.
If you have any concern that Bankruptcy Court might not catch her shenanigans, you can tip them off after she files by calling the U.S. Trustee’s Office in your area, listed in the blue pages of your local phone book.
*
It’s a Mistake to Rush Into Bankruptcy
Q: You recently answered a question from a woman who had filed for bankruptcy and was wondering if she would pay more for a mortgage because of it. Your answer--that she ultimately would pay more because she bailed on her debts--was technically correct but kind of harsh. After all, she could have filed for bankruptcy for reasons beyond her control.
A: There are lots of reasons to file for bankruptcy, including job loss, divorce and overwhelming medical bills, among others. There’s not much excuse, however, for filing before you understand the consequences, as this woman apparently did. Anyone considering bankruptcy should know the costs and research the alternatives before turning to the courts. One good source of information is “Money Troubles: Legal Strategies to Cope With Your Debts,” by Robin Leonard and Deanne Loonin (Nolo Press, 2001).
Unfortunately, some consumers rush into bankruptcy without understanding that the filing will affect their credit record for 10 years. People who file for bankruptcy will have more trouble getting loans, and pay more for them, than if they hadn’t filed.
The woman who wrote might be able to get a mortgage shortly after her bankruptcy was finished, but she would pay high fees and an interest rate three to five percentage points higher than someone with good credit.
The bankruptcy penalty diminishes over time, especially if she cleans up her act and pays her bills promptly. If she maintains good credit, she may be able to qualify for an Federal Housing Administration loan a few years after her bankruptcy.
FHA loans currently average 6.76%, compared with about 6.3% for standard 30-year loans, according to Bankrate.com, which tracks interest rates.
FHA borrowers also must pay mortgage insurance, which boosts their monthly payments. This insurance, referred to as mutual mortgage insurance, or MMI, costs 0.5% of the loan amount a year, or $500 a year on a $100,000 loan.
These extra costs reflect the additional risk lenders take when they make loans to people who already have bailed on their obligations.
*
Liz Pulliam Weston is a personal finance writer for The Times and a graduate of the personal financial planning certificate program at UC Irvine. Questions can be sent to her at money talk@latimes.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012. She regrets that she cannot respond personally to queries. For past Money Talk questions and answers, visit The Times’ Web site at www .latimes.com/moneytalk.
